Please refer to our Second Quarter 2018 Earnings Presentation Supplement available at http://investors.inovalon.com for additional information, including slides pertaining to new Platform offerings, financial details, and other matters that will be referenced during the Company’s conference call.

“Inovalon executed well across several important initiatives in the second quarter of 2018, delivering strong financial results and further expanding our platform capabilities, differentiation, and adoption in the marketplace,” said Keith Dunleavy, M.D., Inovalon’s chief executive officer and chairman of the board. “The progress achieved in the period was the result of a longstanding focus on innovation, great client partner relationships, a discipline towards cost efficiencies, and a tremendous effort from the entire Inovalon team as we execute on our vision to empower data-driven healthcare.”

Second Quarter 2018 Financial Results

Revenue for the second quarter of 2018 was $152.8 million, a year-over-year increase of 38% compared with $110.6 million for the second quarter of 2017, and a sequential increase of 65% compared with $92.8 million for the first quarter of 2018.

Cost of revenue for the second quarter of 2018 was $39.0 million, or 25.5% of revenue, compared with $37.2 million, or 33.6% of revenue for the second quarter of 2017, and $33.5 million, or 36.1% of revenue for the first quarter of 2018. This equates to gross margin for the second quarter of 2018 of 74.5%, a year-over-year increase of 810 basis points compared with 66.4% for the second quarter of 2017, and a sequential increase of 1,060 basis points compared with 63.9% for the first quarter of 2018.

Net loss for the second quarter of 2018 was $10.5 million, resulting in net loss of $0.07 per share, compared with net income of $5.5 million and diluted net income of $0.04 per share, respectively, for the second quarter of 2017, and a net loss of $16.8 million and net loss of $0.12 per share, respectively, for the first quarter of 2018. Net loss for the second quarter of 2018 includes a one-time restructuring expense of $9.5 million.

Adjusted EBITDA for the second quarter of 2018 was $52.8 million, a year-over-year increase of 90% compared with $27.7 million for the second quarter of 2017, and a sequential increase of 571% compared with $7.9 million for the first quarter of 2018. Adjusted EBITDA margin for the second quarter of 2018 was 34.6%, a year-over-year increase of 950 basis points compared with 25.1% for the second quarter of 2017, and a sequential increase of 2,610 basis points compared with 8.5% for the first quarter of 2018.

Non-GAAP net income for the second quarter of 2018 was $19.3 million, resulting in Non-GAAP net income per share of $0.13, increases of 64% and 63%, respectively, compared with $11.8 million and $0.08 per share, respectively, for the second quarter of 2017, and Non-GAAP net loss of $5.0 million and a Non-GAAP net loss of $0.04 per share, respectively, for the first quarter of 2018.

Net cash provided by operating activities for the first six months of 2018 was $20.1 million, compared with $41.1 million for the first six months of 2017.

“During the second quarter, the Company executed well across a complex set of initiatives involving nearly every facet of the business,” said Jonathan Boldt, vice president of finance and interim chief financial officer of Inovalon. “The combination of an increasing number of growth engines within the Company and the successful realization of multiple margin improvement initiatives combined to produce strong financial results for the quarter. As we move forward through the balance of the year, we remain dedicated to disciplined execution of our strategic initiatives.”

Adjusted EBITDA, Adjusted EBITDA margin, and Non-GAAP net income are Non-GAAP measures. Net income is the GAAP financial measure most directly comparable to Adjusted EBITDA and Non-GAAP net income. Reconciliations of net income to Adjusted EBITDA and Non-GAAP net income, identifying the differences between net income and each of these Non-GAAP financial measures, are included in this press release after the consolidated financial statements.

Key Highlights

ABILITY Integration. Integration of ABILITY Network progressed well during the second quarter with strong combined team engagement. In addition to achieving cost synergies in-line with previously projected targets and timelines, significant benefits are also being realized through expanded management strength and the application of several strong best-practices resident within ABILITY. Multiple additional new synergy product offerings and capability enhancements are progressing well at various stages of the go-to-market process with in-year launches expected.

Continued Innovation. During the second quarter, the Company continued to advance the capabilities and offerings empowered through the Inovalon ONE® Platform. Direct EHR connectivity, even before the addition of connectivity gained through ABILITY, expanded to more than 185,000 unique physicians. This reflects a year-over-year increase of more than 70%, further increasing the market value and supporting adoption and growth of the Company’s recently released Clinical Data Extraction as a Service (CDEaaS™) solution. Additionally, the completion of a two-year development project produced the capability referred to as Elastic Container Technology, or ECT™ (as announced by the Company on July 26, 2018), enabling significant expansion in cloud-based computational speed, elasticity, resiliency, and scalability, while also reducing related technology operating costs materially.

Inovalon ONE® Platform Adoption. During the second quarter, the Company saw continued expansion of interest and adoption of cloud-based SaaS solutions enabled by the Inovalon ONE® Platform. Both of the most recent announced platform offerings, specifically CDEaaS™ and ScriptMed™ Cloud, announced on April 10, 2018 and May 8, 2018 respectively, achieved multiyear contract wins during the quarter. Most notable was the five-year engagement to implement ScriptMed™ Cloud announced with AllianceRx Walgreens Prime (ARxWP) to support all ARxWP Specialty Pharmacy operations. Specialty Pharmacy is the fastest growing segment of the healthcare ecosystem, growing rapidly from approximately $178 billion in 2015 to a projected $282 billion by 2020 according to industry analysts. ScriptMed™ Cloud brings to this marketplace a cloud native, SaaS-based solution empowering a new generation of data-driven specialty pharmacy capabilities, delivering increased efficiency, lower operating costs, and improved patient outcomes and experience.

Expanding Efficiencies and Profitability. During the second quarter, Inovalon executed a broad range of efficiency-enhancement and cost-reduction initiatives, both as part of its ongoing margin expansion goals, as well as related to the recent acquisition and ongoing integration of ABILITY. Key to these were a focus on increasing automation, further expansion of industry connectivity, and cost reduction actions to consolidate facilities and eliminate redundant functions. Reflecting the cost reduction actions, a one-time restructuring expense of $9.5 million was incurred during the period. In addition to the aforementioned cost efficiency initiatives, the ongoing expansion of the Company’s technology-enabled capabilities resulted in a continued positive product mix shift towards high-value SaaS offerings. The combined benefits of these factors can be seen in the Company’s strong margin performance in the second quarter of 2018, as well as in the strong financial performance expected going forward in 2018.

Other Financial Data and Key Metrics

The following constitute other financial data and key metrics which are presented quarterly.

Growth of Datasets: At June 30, 2018, the MORE2 Registry® dataset contained more than 252 million unique patient counts and 39 billion medical event counts, increases of 10% and 31%, respectively, compared with June 30, 2017. Data resulting from the integration with ABILITY is not yet reflected within the MORE2 Registry® dataset and is therefore not reflected within the aforementioned data metrics as of this date.

Investment in Innovation: For the quarter ended June 30, 2018, Inovalon’s ongoing investment supporting innovations in advanced, cloud-based platforms empowering data-driven healthcare was $19.6 million, or 12% of revenue, a decrease of $2.3 million, or 10%, compared to the prior year period.

Analytical Process Count Growth: Inovalon’s trailing 12-month Patient Analytics Months (PAM) count, which the Company believes is indicative of the Company’s overall level of analytical activity, grew to 46.2 billion as of June 30, 2018, an increase of 48% as compared with June 30, 2017.

Please see the Company’s filings with the Securities and Exchange Commission (“SEC”) for further detail regarding the preceding other financial data and key metrics.

Shares Outstanding

As of July 20, 2018, the Company had 72.1 million shares of Class A common stock outstanding and 80.6 million shares of Class B common stock outstanding.

2018 Financial Guidance

The Company is updating full-year 2018 financial guidance to reflect: 1) expenses incurred from one-time restructuring initiatives undertaken during the second quarter of 2018, 2) increased fair-value contingent consideration in the setting of strong performance during the second quarter of 2018, 3) increased non-cash intangible asset amortization expense associated with the purchase accounting related to the ABILITY acquisition, 4) increased capital expenditures in response to increased business engagements, and 5) the increased Non-GAAP profitability of the Company.

Capital expenditure is defined as the sum of purchases of property and equipment and investment in capitalized software.

Additional assumptions made within the Company's 2018 guidance are as follows:

While changes in the stock price could change the fully diluted share count, under the treasury stock method, 2018 guidance assumes 146 million weighted average diluted shares.

2018 guidance assumes an effective tax rate of approximately 30% for the full year.

Reconciliations of net income, the GAAP financial measure most directly comparable to Adjusted EBITDA and Non-GAAP net income, and of net cash provided by operating activities, the GAAP financial measure most directly comparable to Non-GAAP net cash provided by operating activities, identifying the differences between each of these Non-GAAP financial measures and the most directly comparable GAAP financial measure, are included in this press release after the consolidated financial statements.

Conference Call

Inovalon will host a conference call to discuss its second quarter 2018 results at 5:00 p.m. Eastern Time today. To participate in Inovalon’s conference call, please dial (855) 783-2604, conference ID 4078088; international callers should dial (631) 485-4882 using the same conference ID. A replay will be available on Inovalon’s investor relations website (http://investors.inovalon.com).

Please refer to our Second Quarter 2018 Earnings Presentation Supplement available at http://investors.inovalon.com for additional information, including slides pertaining to new Platform offerings, financial details, and other matters that will be referenced during the Company’s conference call.

About the Inovalon ONE® Platform

The Inovalon ONE® Platform is an integrated cloud-based platform of more than 80 individual proprietary technology toolsets and deep data assets able to be rapidly configured to empower the operationalization of large-scale, data-driven healthcare initiatives. Each proprietary technology toolset is referred to as a Component, which are grouped into Modules, and informed by the data of billions of medical events within Inovalon’s proprietary datasets. Combinations of Components and Modules are configured to empower highly differentiated solutions for client needs quickly and in a highly scalable fashion. The flexibility of the modular design of the Platform enables clients to integrate the capabilities of the Platform with their own internal capabilities or other third-party solutions. The Platform brings to the marketplace a highly extensible, national-scale capability to interconnect with the healthcare ecosystem on a massive scale, aggregate and analyze data in petabyte volumes, arrive at sophisticated insights in real-time, and drive meaningful impact wherever it is analytically identified best to intervene and intuitively visualize data and information to inform business strategy and execution.

About Inovalon

Inovalon is a leading technology company providing cloud-based platforms empowering data-driven healthcare. Through the Inovalon ONE® Platform, Inovalon brings to the marketplace a national-scale capability to interconnect with the healthcare ecosystem, aggregate and analyze data in real-time, and empower the application of resulting insights to drive meaningful impact at the point of care. Leveraging its platform, unparalleled proprietary data sets, and industry-leading subject matter expertise, Inovalon enables better care, efficiency, and financial performance across the healthcare ecosystem. From health plans and provider organizations, to pharmaceutical, medical device, and diagnostics companies, Inovalon's unique achievement of value is delivered through the effective progression of “Turning Data into Insight, and Insight into Action®.” Providing technology that supports a client base approaching 500 healthcare organizations, Inovalon's platforms and analytics are informed by data pertaining to more than 943,000 physicians, 499,000 clinical facilities, 252 million Americans, and 39 billion medical events. For more information, visit www.inovalon.com.

Forward Looking Statements

Certain statements contained in this press release constitute forward-looking statements within the meaning of, and are intended to be covered by the safe harbor provisions of, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements contained in this press release other than statements of historical fact, including but not limited to statements regarding the roll-out of any product or capability, the timing, performance characteristics and utility of any such product or capability, and the impact of any such product or capability on the healthcare industry, future results of operations and financial position, business strategy and plans, market growth, and objectives for future operations, are forward-looking statements. The words “believe,” “may,” “see,” “will,” “estimate,” “continue,” “anticipate,” “assume,” “intend,” “expect,” “project,” “look forward,” and similar expressions are intended to identify forward-looking statements. Forward-looking statements in this press release include, but are not limited to, statements regarding the expected benefits and impact of the combination of Inovalon and ABILITY, expectations about future business plans, prospective performance and opportunities, strategies and business plans, expectations regarding future results, expectations regarding the size of our datasets, and financial guidance for 2018. Inovalon has based these forward-looking statements largely on current expectations and projections about future events and trends that may affect financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs as of the date of this press release. These forward-looking statements are subject to a number of risks, uncertainties, and assumptions, which could cause the future events and trends discussed in this press release not to occur and could cause actual results to differ materially and adversely from those anticipated or implied in the forward-looking statements.

These risks, uncertainties, and assumptions include, among others: the Company’s ability to continue and manage growth, including successfully integrating ABILITY; ability to grow the client base, retain and renew the existing client base and maintain or increase the fees and activity with existing clients; the effect of the concentration of revenue among top clients; the ability to innovate new services and adapt platforms and toolsets; the ability to successfully implement growth strategies, including the ability to expand into adjacent verticals, such as direct to consumer, growing channel partnerships, expanding internationally and successfully pursuing acquisitions; the ability to successfully integrate our acquisitions and the ability of the acquired business to perform as expected; the successful implementation and adoption of new platforms and solutions, including the Inovalon ONE® Platform, ScriptMed™ Cloud, Clinical Data Extraction as a Service (CDEaaS™), Natural Language Processing as a Service (NLPaaS™), and Elastic Container Technology (ECT™); the possibility of technical, logistical or planning issues in connection with the Company’s investment in and successful deployment of the Company’s products, services and technological advancements; the ability to enter into new agreements with existing or new platforms, products and solutions in the timeframes expected, or at all; the impact of pending M&A activity in the managed care industry, including potential positive or negative impact on existing contracts or the demand for new contracts; the effects of and costs associated with compliance with regulations applicable to the Company, including regulations relating to data protection and data privacy; the effects of changes in tax laws in the jurisdictions in which we operate, including the Tax Cuts and Jobs Act of 2017; the ability to protect the privacy of clients’ data and prevent security breaches; the effect of competition on the business; the timing, size and effect of business realignment and restructuring charges; and the efficacy of the Company’s platforms and toolsets. Additional information is also set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on February 21, 2018, included under the heading Item 1A, “Risk Factors,” and in subsequent filings with the SEC. The Company is under no duty to, and disclaims any obligation to, update any of these forward-looking statements after the date of this press release or conform these statements to actual results or revised expectations, except as required by law.

Use of Non-GAAP Financial Measures

In the Company’s earnings releases, prepared remarks, conference calls, slide presentations and webcasts, there may be use or discussion of non-GAAP financial measures. The GAAP financial measure most directly comparable to each non-GAAP financial measure used or discussed, and a reconciliation of the differences between the comparable GAAP financial measure and each non-GAAP financial measure are included in this press release after the consolidated financial statements.

Inovalon Holdings, Inc.

Consolidated Statements of Operations (unaudited)

(In thousands, except per-share amounts)

Three Months Ended June 30,

Six Months Ended June 30,

2018

2017

2018

2017

Revenue

$

152,798

$

110,578

$

245,553

$

218,884

Expenses:

Cost of revenue(1)

39,015

37,198

72,506

75,483

Sales and marketing(1)

12,045

8,849

19,947

16,436

Research and development(1)

7,545

7,282

13,966

15,070

General and administrative(1)

60,174

35,874

109,570

71,719

Depreciation and amortization

26,906

12,479

43,286

24,964

Restructuring expense

9,464

—

9,464

—

Total operating expenses

155,149

101,682

268,739

203,672

(Loss) Income from operations

(2,351

)

8,896

(23,186

)

15,212

Other income and (expenses):

Realized losses on short-term investments

—

—

(1,035

)

—

Loss on disposal of equipment

(382

)

(138

)

(467

)

(138

)

Loss on extinguishment of debt

(129

)

—

(129

)

—

Interest income

154

1,342

1,549

2,680

Interest expense

(15,568

)

(1,519

)

(17,450

)

(2,932

)

(Loss) Income before taxes

(18,276

)

8,581

(40,718

)

14,822

(Benefit from) Provision for income taxes

(7,810

)

3,095

(13,418

)

5,694

Net (loss) income

$

(10,466

)

$

5,486

$

(27,300

)

$

9,128

Net (loss) income attributable to common stockholders, basic and diluted

$

(10,466

)

$

5,338

$

(27,300

)

$

8,913

Net (loss) income per share attributable to common stockholders, basic and diluted:

Basic net (loss) income per share

$

(0.07

)

$

0.04

$

(0.19

)

$

0.06

Diluted net (loss) income per share

$

(0.07

)

$

0.04

$

(0.19

)

$

0.06

Weighted average shares of common stock outstanding:

Basic

147,181

142,632

143,301

143,680

Diluted

147,181

143,072

143,301

144,123

_______________________________________________________

(1)

Includes stock-based compensation expense as follows:

Cost of revenue

$

(87

)

$

410

$

53

$

715

Sales and marketing

(401

)

505

68

895

Research and development

330

307

958

580

General and administrative

2,802

2,525

5,313

5,154

Total stock-based compensation expense

$

2,644

$

3,747

$

6,392

$

7,344

Inovalon Holdings, Inc.

Consolidated Balance Sheets (unaudited)

(In thousands, except share and par value amounts)

June 30, 2018

December 31, 2017

ASSETS

Current assets:

Cash and cash equivalents

$

68,007

$

208,944

Short-term investments

15,674

267,288

Accounts receivable (net of allowances of $3,788 and $2,038 at June 30, 2018 and December 31, 2017, respectively)

114,121

90,054

Prepaid expenses and other current assets

17,982

10,441

Income tax receivable

12,868

11,987

Total current assets

228,652

588,714

Non-current assets:

Property, equipment and capitalized software, net

139,626

125,768

Goodwill

934,693

184,932

Intangible assets, net

584,678

89,326

Other assets

17,034

6,338

Total assets

$

1,904,683

$

995,078

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:

Accounts payable and accrued expenses

$

27,033

$

34,109

Accrued compensation

18,602

18,592

Other current liabilities

41,325

15,277

Deferred revenue

18,195

6,954

Deferred rent

540

1,818

Credit facilities

9,800

45,000

Capital lease obligation

1,796

336

Total current liabilities

117,291

122,086

Non-current liabilities:

Credit facilities, less current portion

940,038

191,250

Capital lease obligation, less current portion

14,940

12,109

Deferred rent, less current portion

2,838

219

Other liabilities

20,029

—

Deferred income taxes

115,624

26,642

Total liabilities

1,210,760

352,306

Commitments and contingencies

Stockholders' equity:

Common stock, $0.000005 par value, 900,000,000 shares authorized, zero shares issued and outstanding at each of June 30, 2018 and December 31, 2017, respectively

Inovalon defines Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization (Adjusted EBITDA) as net income or loss calculated in accordance with GAAP, adjusted for the impact of depreciation and amortization, realized losses on short-term investments, loss or gain on disposal of equipment, loss on debt extinguishment, interest income, interest expense, provision for income taxes, stock-based compensation, acquisition costs, restructuring expense, tax on equity exercises, and other non-comparable items. Adjusted EBITDA margin is defined as Adjusted EBITDA as a percentage of revenue. A reconciliation of net income to Adjusted EBITDA follows:

(In thousands, except percentages)

Three Months Ended June 30,

Six Months Ended June 30,

2018

2017

2018

2017

Reconciliation of net (loss) income to Adjusted EBITDA:

Net (loss) income

$

(10,466

)

$

5,486

$

(27,300

)

$

9,128

Depreciation and amortization

26,906

12,479

43,286

24,964

Realized losses on short-term investments

—

—

1,035

—

Loss on disposal of equipment

382

138

467

138

Loss on debt extinguishment

129

—

129

—

Interest income

(154

)

(1,342

)

(1,549

)

(2,680

)

Interest expense

15,568

1,519

17,450

2,932

(Benefit from) Provision for income taxes

(7,810

)

3,095

(13,418

)

5,694

EBITDA

24,555

21,375

20,100

40,176

Stock-based compensation

2,644

3,747

6,392

7,344

Acquisition costs:

Transaction costs

1,287

21

4,639

121

Integration costs

2,445

168

3,202

881

Contingent consideration accretion

8,500

1,300

8,700

1,300

Compensatory contingent consideration

1,229

(433

)

1,787

497

Restructuring expense

9,464

—

9,464

—

Tax on equity exercises

—

—

—

32

Other non-comparable items(1)

2,680

1,552

6,392

2,332

Adjusted EBITDA

$

52,804

$

27,730

$

60,676

$

52,683

Adjusted EBITDA margin

34.6

%

25.1

%

24.7

%

24.1

%

_______________________________________________________

(1)

Other “non-comparable items” include items that are not comparable across reporting periods or items that do not otherwise relate to the Company’s ongoing financial results, such as certain employee related expenses attributable to advancements in automation and operational efficiencies, and legal expenses beyond those in the normal course of business. Non-comparable items are excluded from Adjusted EBITDA in order to more effectively assess the Company’s period over period and ongoing operating performance.

Inovalon Holdings, Inc.Non-GAAP net (loss) income (unaudited)

Inovalon defines Non-GAAP net income as net income or loss calculated in accordance with GAAP, adjusted to exclude tax-affected stock-based compensation expense, acquisition costs, restructuring expense, amortization of acquired intangible assets, tax on equity exercises, and other non-comparable items. The Company defines Non-GAAP basic net income per share as Non-GAAP net income divided by basic weighted average shares outstanding. The Company defines Non-GAAP diluted net income per share as Non-GAAP net income divided by diluted weighted average shares outstanding. A reconciliation of net income to Non-GAAP net income follows:

(In thousands, except per-share amounts)

Three Months Ended June 30,

Six Months Ended June 30,

2018

2017

2018

2017

Reconciliation of net (loss) income to Non-GAAP net income:

Net (loss) income

$

(10,466

)

$

5,486

$

(27,300

)

$

9,128

Stock-based compensation

2,644

3,747

6,392

7,344

Acquisition costs:

Transaction costs

1,287

21

4,639

121

Integration costs

2,445

168

3,202

881

Contingent consideration accretion

8,500

1,300

8,700

1,300

Compensatory contingent consideration

1,229

(433

)

1,787

497

Amortization of acquired intangible assets

13,797

3,761

17,648

7,535

Restructuring expense

9,464

—

9,464

—

Tax on equity exercises

—

—

—

32

Other non-comparable items(1)

2,680

1,552

6,392

2,332

Tax impact of add-back items

(12,290

)

(3,826

)

(16,593

)

(7,716

)

Non-GAAP net income

$

19,290

$

11,776

$

14,331

$

21,454

GAAP basic net (loss) income per share

$

(0.07

)

$

0.04

$

(0.19

)

$

0.06

GAAP diluted net (loss) income per share

$

(0.07

)

$

0.04

$

(0.19

)

$

0.06

Non-GAAP basic net income per share

$

0.13

$

0.08

$

0.10

$

0.15

Non-GAAP diluted net income per share

$

0.13

$

0.08

$

0.10

$

0.15

Weighted average shares of common stock outstanding:

Basic

147,181

142,632

143,301

143,680

Diluted

147,332

143,072

143,540

144,123

_______________________________________________________

(1)

Other “non-comparable items” include items that are not comparable across reporting periods or items that do not otherwise relate to the Company’s ongoing financial results, such as certain employee related expenses attributable to advancements in automation and operational efficiencies, and legal expenses beyond those in the normal course of business. Non-comparable items are excluded from Non-GAAP net income in order to more effectively assess the Company’s period over period and ongoing operating performance.

Inovalon Holdings, Inc.Key Metrics (unaudited)

The Company believes the key metrics illustrated in the tables below are indicative of its overall level of analytical activity and its underlying growth in the business. Data resulting from the integration with ABILITY Network is not yet reflected within the MORE2 Registry® dataset and is therefore not reflected within the related data metrics below as of this date.

June 30,

(In thousands)

2018

2017

MORE2 Registry® dataset metrics

Unique patient count(1)(4)

252,603

230,000

Medical event count(2)(4)

39,333,463

30,000,000

Trailing 12 month Patient Analytics Months (PAM)(3)

46,152,155

31,226,926

_______________________________________________________

(1)

Unique patient count is defined as each unique, longitudinally matched, de-identified natural person represented in the MORE2 Registry® as of the end of the period presented.

(2)

Medical event count is defined as the total number of discrete medical events as of the end of the period presented (for example, a discrete medical event typically results from the presentation of a patient to a physician for the diagnosis of diabetes and congestive heart failure in a single visit, the presentation of a patient to an emergency department for chest pain, etc.).

(3)

Patient Analytics Months, or PAM, is defined as the sum of the analytical processes performed on each respective patient within patient populations covered by clients under contract. As used in the metric, an “analytical process” is a distinct set of data calculations undertaken by the Company which is initiated and completed within the Company’s platform solutions to examine a specific question such as whether a patient is believed to have a condition such as diabetes, or worsening of the disease, during a specific time period.

(4)

At the end of the year-ago quarter, specifically as of June 30, 2017, the Company was processing large unique patient count and medical event count dataset transmissions. For this reason, June 30, 2017 unique patient count and medical event count amounts vary from historical calculation methodologies, and represent estimates pending final MORE2 Registry® dataset incorporation and processing.

Inovalon Holdings, Inc.Investment in Innovation (unaudited)

The Company’s business model is based upon the ability to deliver value to clients through the combination of advanced, cloud-based data analytics and data-driven intervention platforms focused on the achievement of meaningful and measurable improvements in clinical quality outcomes and financial performance in healthcare. The Company’s ability to deliver this value is dependent in part on the ability to continue to innovate, design new capabilities, and bring these capabilities to market in an enterprise scale. The Company’s continued ability to innovate the platform and bring differentiated capabilities to market is an important aspect of the Company’s business success. The Company’s investment in innovation includes costs for research and development, capitalized software development, and expenditures related to hardware and software platforms on which data analytics and data-driven interventions capabilities are deployed as summarized below.

Three Months Ended June 30,

Six Months Ended June 30,

(In thousands, except percentages)

2018

2017

2018

2017

Investment in Innovation:

Research and development(1)

$

7,545

$

7,282

$

13,966

$

15,070

Capitalized software development(2)

11,366

8,793

21,662

14,933

Research and development infrastructure investments(3)

727

5,828

9,492

9,586

Total investment in innovation

$

19,638

$

21,903

$

45,120

$

39,589

As a percentage of revenue

Research and development(1)

5

%

7

%

6

%

7

%

Capitalized software development(2)

7

%

8

%

9

%

7

%

Research and development infrastructure investments(3)

—

%

5

%

4

%

4

%

Total investment in innovation

12

%

20

%

19

%

18

%

_______________________________________________________

(1)

Research and development primarily includes employee costs related to the development and enhancement of the Company’s service offerings.

(2)

Capitalized software development includes capitalized costs incurred to develop and enhance functionality for the Company’s data analytics and data-driven intervention platforms.

(3)

Research and development infrastructure investments include strategic expenditures related to hardware and software platforms under development or enhancement.

Reconciliation of Forward-Looking Guidance Net Income to Adjusted EBITDA:

Net (loss) income

$

(24

)

$

(18

)

Depreciation and amortization

96

96

Interest expense

49

49

Interest income

(2

)

(2

)

Realized losses on short-term investments

1

1

Benefit from income taxes(1)

(13

)

(10

)

EBITDA

107

116

Stock-based compensation

15

15

Acquisition costs:

Transaction costs

7

7

Integration costs

7

8

Contingent consideration accretion

10

10

Compensatory contingent consideration

4

4

Restructuring expense

9

9

Other non-comparable items(2)

7

7

Adjusted EBITDA

$

166

$

176

Adjusted EBITDA margin

29.2

%

29.7

%

_______________________________________________________

(1)

A 30% tax rate is assumed in order to approximate the Company’s effective statutory corporate tax rate.

(2)

Other “non-comparable items” include items that are not comparable across reporting periods or items that do not otherwise relate to the Company’s ongoing financial results, such as certain employee related expenses attributable to advancements in automation and operational efficiencies, and legal expenses beyond those in the normal course of business. Non-comparable items are excluded from Adjusted EBITDA in order to more effectively assess the Company’s period over period and ongoing operating performance.

Reconciliation of Forward-Looking Guidance Net Income to Non-GAAP net income:

Net (loss) income

$

(24

)

$

(18

)

Stock-based compensation

15

15

Acquisition costs:

Transaction costs

7

7

Integration costs

7

8

Contingent consideration accretion

10

10

Compensatory contingent consideration

4

4

Amortization of acquired intangible assets

45

45

Restructuring expense

9

9

Other non-comparable items(1)

7

7

Tax impact of add-back items(2)

(30

)

(29

)

Non-GAAP net income

$

50

$

58

GAAP diluted net income per share

$

(0.16

)

$

(0.12

)

Non-GAAP diluted net income per share

$

0.34

$

0.40

Weighted average shares of common stock outstanding - diluted

146

146

_______________________________________________________

(1)

Other “non-comparable items” include items that are not comparable across reporting periods or items that do not otherwise relate to the Company’s ongoing financial results, such as certain employee related expenses attributable to advancements in automation and operational efficiencies, and legal expenses beyond those in the normal course of business. Non-comparable items are excluded from non-GAAP net income in order to more effectively assess the Company’s period over period and ongoing operating performance.

(2)

A 30% tax rate is assumed in order to approximate the Company’s effective statutory corporate tax rate.

The Company defines Non-GAAP net cash provided by operating activities as net cash provided by operating activities calculated in accordance with GAAP, adjusted to exclude certain acquisition costs, specifically transaction costs and integration costs. The Company uses Non-GAAP net cash provided by operating activities as a liquidity measure to evaluate its ability to generate cash to support its ongoing business operations, to service and repay debt, and to invest in its businesses. A reconciliation of forward-looking preliminary net cash provided by operating activities to forward-looking preliminary Non-GAAP net cash provided by operating activities follows:

Inovalon provides the measures Adjusted EBITDA, Adjusted EBITDA margin, and Non-GAAP net income as additional information for evaluating the Company’s operating results and Non-GAAP net cash provided by operating activities as a liquidity measure to evaluate the Company's ability to generate cash to support its ongoing business, to service and repay debt, and to invest in its business. These measures are not prepared in accordance with, or as an alternative for, GAAP accounting and may be different from non-GAAP measures used by other companies.

Investors frequently have requested information from management regarding depreciation, amortization and other non-cash charges, such as stock-based compensation, as well as the impact of non-comparable items and management believes, based on discussions with investors, that these non-GAAP measures enhance investors’ ability to assess Inovalon’s historical and projected future financial performance. While management believes these non-GAAP financial measures provide useful supplemental information to investors, there are limitations associated with the use of non-GAAP financial measures. For example, one limitation of Adjusted EBITDA is that it excludes depreciation and amortization, which represents the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our business. Inovalon compensates for these limitations by using these non-GAAP financial measures as supplements to GAAP financial measures and by reconciling the non-GAAP financial measures to their most comparable GAAP financial measures. Investors are encouraged to review the reconciliations of these non-GAAP financial measures to the comparable GAAP measures that are provided above.

These non-GAAP measures include financial information that is prepared in accordance with GAAP and presented in our consolidated financial statements and are used to evaluate our business, measure our performance, develop financial forecasts and make strategic decisions and are an important factor in determining variable compensation.

Adjusted EBITDA and Adjusted EBITDA Margin

The Company defines Adjusted EBITDA as net income calculated in accordance with GAAP, adjusted for the impact of depreciation and amortization, realized losses on short-term investments, loss or gain on disposal of equipment, interest income, interest expense, provision for income taxes, stock-based compensation, acquisition costs (including transaction costs, integration costs, costs related to contingent consideration accretion and compensatory contingent consideration), restructuring expense, tax on equity exercises, and other non-comparable items. A reconciliation of net income, which is the most directly comparable GAAP financial measure, to Adjusted EBITDA is provided above.

Adjusted EBITDA margin is the Company’s calculation of Adjusted EBITDA, divided by revenue calculated in accordance with GAAP.

The Company uses Adjusted EBITDA and Adjusted EBITDA margin as supplemental measures of performance to gain insight into operating effectiveness. The Company uses Adjusted EBITDA and Adjusted EBITDA margin as key metrics to assess its ability to increase revenues while controlling expense growth and the scalability of the Company’s business model. The Company believes that the exclusion of the expenses eliminated in calculating Adjusted EBITDA and Adjusted EBITDA margin provides management and investors a useful measure for period-to-period comparisons of the Company’s core business and operating results by excluding items that are not comparable across reporting periods or that do not otherwise relate to the Company’s ongoing operating results. Accordingly, the Company believes that Adjusted EBITDA and Adjusted EBITDA margin provide useful information to investors and others in understanding and evaluating the Company’s operating results. However, use of Adjusted EBITDA and Adjusted EBITDA margin as analytical tools has limitations, and investors and others should not consider them in isolation or as substitutes for analysis of our financial results as reported under GAAP. In addition, other companies, including companies in Inovalon’s industry, might calculate Adjusted EBITDA and Adjusted EBITDA margin or similarly titled measures differently, which may reduce their usefulness as comparative measures.

The Company defines Non-GAAP basic net income per share as Non-GAAP net income divided by basic weighted average shares outstanding. The Company defines Non-GAAP diluted net income per share as Non-GAAP net income divided by diluted weighted average shares outstanding.

The Company uses Non-GAAP net income as a supplemental measure of performance to gain insight into financial effectiveness. The Company uses Non-GAAP net income as a key metric to assess its ability to increase revenues while controlling expense growth and the scalability of its business model. The Company believes that the exclusion of the expenses eliminated in calculating Non-GAAP net income provides management and investors a useful measure for period to period comparisons of the Company’s core business and financial results by excluding items that are not comparable across reporting periods or that do not otherwise relate to its ongoing financial results. Accordingly, the Company believes that Non-GAAP net income provides useful information to investors and others in understanding and evaluating the Company’s performance. However, use of Non-GAAP net income as an analytical tool has limitations, and investors and others should not consider this measure in isolation or as a substitute for analysis of the Company’s financial results as reported under GAAP. In addition, other companies, including companies in Inovalon’s industry, might calculate Non-GAAP net income or similarly titled measures differently, which may reduce their usefulness as comparative measures.

Non-GAAP net cash provided by operating activities

The Company defines Non-GAAP net cash provided by operating activities as net cash provided by operating activities calculated in accordance with GAAP, adjusted to exclude certain acquisition costs, specifically transaction costs and integration costs. The Company uses Non-GAAP net cash provided by operating activities as a liquidity measure to evaluate its ability to generate cash to support its ongoing business operations, to service and repay debt, and to invest in its businesses. The Company believes that the exclusion of certain acquisition costs in calculating Non-GAAP net cash provided by operating activities provides management and investors a useful measure for the expected cash flows generated from the Company’s core business by excluding items that do not otherwise relate to its ongoing liquidity. However, use of Non-GAAP net cash provided by operating activities has limitations, and investors and others should not consider this measure in isolation or as a substitute for analysis of the Company’s liquidity as reported under GAAP. In addition, other companies, including companies in Inovalon’s industry, might calculate Non-GAAP net cash provided by operating activities or similarly titled measures differently, which may reduce their usefulness as comparative measures.

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